The 10-year Treasury yield is historically low, so low that it could climb a full 1% before the end of the year and still be the lowest year-end yield on record, with room to spare. Historically low rates come with a genuine concern that they can reverse and climb higher, which could be painful for Treasury investors. The good news: As shown in LPL’s chart of the day, four out of five of the worst years for estimated 10-year Treasury returns have been mid- to late cycle, which is not the stage that we’re in now.
“What pushes up Treasury yields? Growth, inflation, or the Fed,” said LPL Chief Market Strategist Ryan Detrick. “But what do we have? Growth, sure, but inflation looks tame and the Fed has signaled they may be on hold for a while.”
Looking at the five worst years of estimated 10-year Treasury performance, there’s an interesting mix of drivers. There’s a period of high (and rising) inflation (1969) when the Fed was raising rates, hurting stock returns. There are two cases of the Fed pumping the breaks during a strong period of growth (1994, 1999). There’s the “taper tantrum” in 2013, when the Fed was just talking about winding down quantitative easing while remaining supportive, but it was still all about the Fed. And then there’s the outlier: 2009.
If you looked at the economic data for every year since 1950, including what the Fed was up to, I don’t think you would pick out 2009 as a year when yields jumped, nevermind the worst period for Treasuries. The stock market rebounded, probably before many expected, as the economy started to recover from a difficult recession, although it wasn’t clear what kind of recovery we would have and there were still many who thought the market rebound was a head fake. The Fed continued to surprise markets by doing things it had just never done before. A massive stimulus bill was signed into law in February. The dollar started to fall. Gold prices started climbing steadily (and would continue to climb until 2011). TIPS yields were diverging from the 10-year Treasury. It’s all eerily similar to signals we’re seeing now—except the 10-year Treasury yield has just been flat.
Despite the similarities, we think a rate surge now is much less likely. The Fed’s commitment to keeping rates low for an extended period of time is stronger; we know now that central bank asset purchases don’t necessarily lead to inflation, and low international yields continue to make Treasuries attractive, even if less so than a year ago.
But despite not seeing a lot of room for rates to rise, we remain cautious on Treasuries. As interest rates fall, bond prices become even more sensitive to rate changes and aren’t generating as much income to offset losses. It’s not surprising to see only one year prior to 1990 make it into the five. Treasuries historically have been the best diversifiers for stock holdings during periods of market declines and that diversification still has value, but with yields low they have never come with more risk as right now.
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